Paul L. Caron

Monday, March 4, 2013

Leff: Medical Marijuana Providers Can Beat Oppressive Federal Taxes by Operating as Non-Profits

Marijuana Following up on last week's post, Medical Marijuana Providers Face 75% Federal Tax Rate:  Slate: Growing the Business: How Legal Marijuana Sellers Can Beat a Draconian Tax,  by Benjamin M. Leff (American):

Eighteen states and the District of Columbia have now decriminalized or legalized marijuana for at least some purposes. You hear a lot about the conflict between these state laws and the federal statute criminalizing the sale and possession of marijuana. But since the Justice Department isn’t consistently coming after marijuana sellers, the more immediate problem for many of them is federal tax law. “The federal tax situation is the biggest threat to businesses and could push the entire industry underground,” the leading trade publication for the marijuana industry reports.

Here’s why: Ordinary businesses are taxed by subtracting their business expenses from their gross revenue to arrive at their net income, or profit. That amount is subject to tax. By contrast, sellers of controlled substances—in other words, drugs, including marijuana—are not permitted to deduct any ordinary business expenses other than the cost of the goods they are selling. That’s because of § 280E of the federal tax code, which Congress enacted in the 1980s to punish drug dealers. The provision was largely symbolic for decades, since few drug dealers filed income tax forms. But now, state-licensed marijuana sellers must pay federal taxes not only on their profits but also on the money they spend on salaries, rent, advertising, and all the other expenses related to running a business. In fact, it is conceivable that § 280E could require a business to pay more in tax than its total profits for the year.

I teach tax law, and I have a solution: Marijuana sellers should operate as nonprofit “social welfare organizations.” To qualify for a federal tax exemption, a social welfare organization must have as its primary purpose the promotion of the common good and general welfare of the people in its neighborhood or community. Currently, many social welfare organizations operate businesses in poor and distressed neighborhoods, providing jobs and job-training for residents and improving the conditions for economic development. For example, Homeboy Industries is a tax-exempt nonprofit that trains and employs former gang members in Los Angeles to work in a bakery, a café, and a retail store. ...

Eventually, it probably makes sense for Congress to repeal § 280E and treat marijuana sellers the same as any other business. If the states want to legalize and regulate marijuana, the federal government shouldn’t use the tax code to interfere. But until that question is settled, avoiding § 280E by operating as a social welfare organization will allow a neighborhood-based seller to be at the forefront of the legalization experiment—while furthering the interests of the local community. All it takes is a few visionary nonprofit entrepreneurs, and an IRS not afraid to do the right thing.

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If I have a pure indica marijuana, and got busted by feds, could I get off because the federal definition of marijuana is "any part of the cannabis sativa plant" Since cannabis sativa is Not cannabis Indica, then there is no case... right?

Posted by: Remolino | Mar 23, 2013 5:25:15 PM

Nice try but the IRS is on the lookout to screen out exemption applications that are stealth applications for medical marijuana dispensing. I have personally participated in the formation of a medical marijuana patient advocacy organization that received its c3 exemption in August 2012. The screening process took over a year due to the sensitive nature of the organization's mission being in potential conflict with federal law. While the IRS worked very closely with our organization, to the agency's credit, we were forced to scrub the entire organization of any references to acquisition, possession, transfer, etc of medical cannabis. As our mission was educational, we were not permitted to provide any instruction in cultivation or secondary processing. The Department of Justice issued guidelines to the IRS EO in August 2011 in regards to Medical Marijuana which starkly defined the framework under which exempt organizations could operate. Keep thinking of creative ideas though, the system has to give at some point. I have been directed by peers to Tellier v. Commissioner (342 f.2d 690, 1965)as a potential crack in 280e.

Posted by: James Campbell | Mar 7, 2013 9:08:05 AM

Anon- I'm not sure your link provides the data used in the video. It's based on a survey of a few thousand households and surely isn't robust enough for that level of generalization. A pity because it would be funny to chastise people as ignorant by using their self-reported numbers.

Posted by: yo Gabbatpour Gabbatpour | Mar 5, 2013 10:42:57 PM

This idea was proposed on this very blog, see second comment here.

Second, "lessening the burdens of government" is a charitable purpose, and the IRS sees that as essentially a local issue on which they defer to local governments. So it should be with "minimum standards of acceptable conduct". Health and Safety Code 11362.5 makes clear that California strongly favors easy access, that it is an important community goal. Having said all that, the Feds can do whatever they want and, under AG Holder, have vigorously attacked distribution that is compliant with state laws.

Posted by: Yo Gabba Gabba | Mar 4, 2013 3:48:24 PM

wow this would be funny. would love to see the shitty gov't finally bend over and legalize it (for $$$$ taxed weed sales)and then these places just turn into none profit! hahaha, this is sorta of what the republicans do with their own high income earning "none profit" ORG's

Posted by: Trisha | Mar 4, 2013 11:21:27 AM

Spoken like a professor who has no idea what the actual state laws are in CA, for instance. They have to operate as non-profits and can only recover "costs." Virtually none of the collectives in CA operate under the law on that point. And under the IRC, where exactly is 4 million dollars a year in net profit, which is what some of these giant ones make, going other than to the shareholder/owner/CEO?

And the above poster is right, the IRS isn't going to grant you non-profit status anyway.

CA has had lawyers advising these 'companies' for 20 years...that is probably where the most understanding resides, not in a professor's office. At least we know how that law school can cut costs now.

Posted by: jdd | Mar 4, 2013 7:59:48 AM

To unpack his argument (which he makes in an article and doesn't expand upon in his Slate article, which strikes this reader as a little dicey......): under Rev Ruling 75-384, the IRS ruled that "illegal activities, which violate the minimum standards of acceptable conduct necessary for the preservation of an orderly society, are contrary to the common good and the general welfare of the people in a community and thus are not permissible means of promoting the social welfare for purposes of section 501(c)(4) of the Code."

His argument is that this is ambiguous, and that it could mean that illegality and violation of minimum standards are actually two separate elements of the test for exemption. I don't buy it, and, given that he's arguing that a claimed ambiguity (which doesn't seem so ambiguous to me) should be resolved in favor of the seller of a controlled substance, I really think he should've made that plain in his Slate article rather than burying the linchpin of his argument 28 pages deep in a draft article.

Posted by: jpe | Mar 4, 2013 6:23:11 AM

Under a long string of IRS rulings, an organization can't be exempt if more than an insubstantial purpose of the org is illegal activity. Under that rule, it's eminently clear that a pot dispensary could not be granted exemption.

Posted by: jpe | Mar 4, 2013 5:57:31 AM